Zomato IPO | Is valuation pricey, can it rustle up winning recipe over long term? Experts weigh in

Also read: Exclusive | Zomato to raise $560 million from anchor Investors for IPO: Sources

Pricier than peers?

The price band of the IPO has been fixed at Rs 72-76 per equity share, which looks pricey.

Analysts usually see the valuation of a stock through different lenses such as price to earnings (P/E), price to book value (P/BV or P/B), price to sales (P/S) and enterprise value-to-sales (EV/sales).

While P/E measures a company's current share price relative to its per share earnings, the P/S ratio shows the stock's price to its revenues. EV/sales ratio compares the total value of the company to its sales.

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P/BV or P/B is the ratio of the current market price of a share to the book value per share. When we divide the book value (net asset value of a company) of a company by the number of shares outstanding, we
find the book value per share of the stock.

"Zomato's valuation at 19.7 times FY22E and 13 times FY23E P/S at the higher end of the price band is higher than the 1-year forward P/S of its global peers which trade at 2-12 times," Pranav Kshatriya, VP,
Institutional Equities, Edelweiss Securities said.

Hemang Jani, Head Equity Strategy, Broking & Distribution, Motilal Oswal Financial Services, said that globally, online food delivery players trade at an average EV/sales of about 10 times.

Also read: Zomato IPO | 'Don't see major listing gains as issue already priced 30% above last round of funding'

Though the majority of them are still loss-making at the PAT level, they have attained a decent business size and have turned EBITDA positive. Zomato is at a very nascent stage and is making losses even at the EBITDA level.

"Thus, if we compare it on EV/sales basis, Zomato is available at 25 times FY21 EV/sales. which is rich when compared to global players who trade at an average of 9.5 times FY21 EV/sales. But if we use P/BV for comparison, then Zomato seems reasonably valued as it is available at 3.5 times FY21 P/BV against global peers average of 10.6 times.

"Since Zomato is at an early stage of its business cycle and may require a long-time frame to turn profitable, especially given the current challenging times, thus valuing it on plain vanilla financial matrix might not give the right picture and may look distorted. Hence while valuing unicorns such as Zomato, one needs to keep in mind the industry's long-term growth potential, Zomato’s strong brand image, early-mover advantage and its strong network and accordingly give premium," said Jani.

Also read: Zomato IPO to open next week: 10 key things to know about the issue and the company

Gaurav Garg, head of research at CapitalVia Global Research underscored that the firm has raised nearly $2 billion since last year, boosting public confidence.

"Even though the firm is losing money, the anchor investors’ valuations have boosted public confidence, with the corporation aiming for a $10-billion valuation in the next five years. With the expected growth in mind, the issue seems to be reasonably priced when viewed in terms of its valuation,” said Garg.

Jitesh Ranawat, Head, Institutional Sales, Marwadi Shares and Finance, agrees that compared to the global peers, the stock looks expensive but there is a tremendous opportunity for growth in the business in view of the large market opportunity available in India and that is the reason it will always look optically expensive compared to its global peers.

"It is the premium of expected growth that is attached to its valuations versus global peers," said Ranawat.

At this juncture, analysts emphasize viewing Zomatio's valuation through the lens of the growth perspective.

"We should not consider valuations on the current profitability only, but also the growth prospects, the strength of the franchisee, management’s ability to create a long-term sustainable and profitable business. The nature of the business is such that losses in the initial few years are imperative leading to unfavourable unit economics," Kshatriya pointed out.

'A long-term growth story'

Zomato posted a consolidated loss of Rs 816.43 crore in the financial year ended March 2021 against a loss of Rs 2,385.6 crore in the previous year.

The company has been making losses but it is also a fast-growing player in a rapidly-growing food delivery business.

The company belongs to the network effect-led business models such as Facebook, Google, Uber, AirBnB, etc. and such companies need to invest heavily in the initial stage to expand their network.

After establishing a strong network, these companies focus on monetisation of the platform.

Prashanth Tapse, VP Research at Mehta Equities, believes Zomato’s business model will take another one or two years to have a sustainable profit-making company. The industry is still in a nascent stage which needs huge cash-burning cycles to acquire new customers to stay in the business for a long time.

Zomato is one of the leading food-services platforms in India in terms of the value of food sold, as of March 31, 2021. It has gained market share over the last four years to become the category leader in the food-delivery space in India in terms of gross order value (GOV) from October 1, 2020, to March 31, 2021, brokerage firm Axis Capital said.

Zomato was available in 23 countries outside India as of March 31, 2021. As per Axis Capital, the company has taken a conscious strategic call to focus only on the Indian market going forward.

Given the large market opportunity in India, a focused Zomato will enhance the value for all its stakeholders, Axis said.

"If you look at the present scenario, some tech companies are among top wealth creators. Business models are changing fast and only time will tell who is the winner. One thing is sure, in a ‘leader-takes-all’ kind of market dynamics, these giant companies can turn the tables if managed well with the ethos of good governance and sustainable growth," said Piyush Nagda, Head-Investment Products at Prabhudas Lilladher.

For those who believe in India's digital story and have a high-risk appetite, there is no harm in allocating a small percentage of the portfolio to such disruptive ideas or themes, Nagda said.

"With growth expected to pick up in the coming years after a Covid impacted FY21, we expect the company to breakeven at the EBIDTA and PAT level in FY22 and FY23, respectively, given improving unit economics.
Given strong multi-year growth prospects and expected turnaround we believe that investors with a long-term investment horizon can invest in the IPO," said Jyoti Roy - DVP- Equity Strategist, Angel Broking.

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